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Wednesday, March 16, 2011

Stock Chart Pattern - Bharat Bijlee (An Update)

The stock chart pattern of Bharat Bijlee is an example of why technical analysis should never be relied upon completely. It is not a science. Price targets are fixed on the basis that previous chart patterns will get repeated. While this happens often, many times the outcomes are contrary to expectations.

Pattern failures happen when there isn’t appropriate volume support. One of the reasons why even fundamentally strong small-cap stocks are risky bets is because they tend to trade in miniscule volumes. That makes buying and selling a difficult proposition. Low volumes also renders technical analysis ineffective.

In the previous update back in May ‘10, I had observed a bearish descending triangle pattern being formed after the stock touched a high of 1170 in Jan ‘10. I had expected the stock to fall below the support level of 880 to a low of 700. Accordingly, I had recommended the following course of action to investors:

‘Existing holders should get out now, or at best, hold with a strict stop-loss at 880. New entrants should avoid the stock.’

Triangles are consolidation patterns that are generally unreliable. That means that the stock price can break out of a triangle in either direction. But ascending triangles (flat top, rising bottoms) and descending triangles (lower tops, flat bottom) tend to be more reliable. Price usually breaks above a flat top or below a flat bottom.

Note that the bearish descending triangle price pattern formed between Jan – Jun ‘10 turned out to be a failure. A burst of buying from the third week of Jun ‘10 propelled the stock price to a high of 1284 on Jul 2 ‘10. After a brief dip, a second burst of buying saw the stock reach 1316 on Jul 22 ‘10.

The fun and games of the bulls finally ran out of steam. While the stock reached a higher top, all four technical indicators made lower tops (marked by blue arrows). The combined negative divergences started a correction within another descending triangle pattern that has lasted almost 8 months.

Through Aug ‘10 and most of Sep ‘10, the stock price was supported by the 50 day EMA as a bearish pattern of lower tops and lower bottoms got formed. The stock found resistance from the downward sloping trend line of the descending triangle pattern on Oct 7 ‘10, and quickly dropped to the 200 day EMA. For the next 3 weeks, the stock traded between the 50 day and 200 day EMAs before decisively breaching the support from the long-term moving average on Nov 15 ‘10.

The ‘death cross’ signalling a bear market (marked by blue oval) happened on Dec 8 ‘10. On the next day, the stock plunged to the support level of 880 on a volume spike. A ‘reversal day’ pattern (lower low, higher close) on Dec 10 ‘10 marked the end of the fall. But the meagre volume suggested that the rally was unlikely to be a strong one. A 3 months long sideways consolidation has ensued, with up moves finding resistance from the 200 day EMA. If the support level of 880 doesn’t get breached soon, the second descending triangle pattern may also turn out to be a failure.

The technical indicators are not showing any clear direction – typical of consolidation periods. The MACD is entangled with the signal line, and both are barely in the positive zone. The ROC has fallen below its 10 day MA into negative territory. The RSI has moved down to its 50% level. The slow stochastic is about to drop to the 50% mark.

Bottomline? The stock chart pattern of Bharat Bijlee is almost back where it was 10 months ago. One can hold with a strict stop-loss at 880, and add only on a high volume break out above the descending triangle. At today’s closing price of 974.25, the stock is trading at less than 25% of its Jan ‘08 bull market peak price of 3950. Fundamentally, the company is financially sound and continues to perform well. But margins are under pressure.

3 comments:

The second formation could also be a downward channel with a false breakout near the death cross. This seems more plausible as the slope of the MACD and ROC is almost flat while the stock moved significantly down. RSI also is still in a narrow range of 30-70%, even after such a big fall - the only time it was not was during the time of the death cross.

I agree with you that volume is very important, and probably the false signal was generated on low volumes. In scrips such as this, it won't make sense to compare the volumes between periods because they would be low anyway. It may make more sense to look at absolute value of stock traded and if that is small, to ignore it. One other way to obviate this is to look at OBV, which removes short-term false signals such as this.

As it looks to me, in the first formation, after the triangle breakout, it superbly met the target (triangle size of about 240 odd rupees?). The second formation to me looks more like a falling channel. Whichever side it breaks, it should give about 120 pts move.

@Nasir: Very pleasant surprise to receive a detailed comment on technicals!

There is a reason for considering the second formation as a descending triangle instead of a downward sloping channel. The 880 level has stood firm for more than a year. It is also cutting through the downward sloping channel.

Within the channel, a breach of 880 may be expected to find support at the lower end of the channel. But since 880 is a long term support, a breach will have more serious consequences - a possible drop below 700. The single day 'flash crash' down to 736 in Dec '10 was an alarm bell. That low is likely to be tested, and broken.

The RSI usually trades between 30-70% - above 70% is the overbought zone and below 30% is the oversold zone. So the range is not 'narrow' but 'normal'.

The OBV has kept rising during the formation of the second descending triangle - thanks to periodic volume spurts followed by several days of low volumes. This would be treated as a positive divergence in a stock that trades in high volumes. But in a small-cap with miniscule volumes of trade, the pattern reeks of a 'pump and dump' operation.

@Sushilbhaya: Thanks for your comments.

The second formation can be drawn as a downward sloping channel, but the reason for treating it as a descending triangle has been explained above.

In technical analysis, everything depends on one's interpretation of the patterns. There is no certainty that any particular interpretation is correct - so one has to take an educated guess.

Since the chart is weak (CMP barely 25% of Jan '08 peak), and the stock is technically in a 3 years long bear market, I chose the more bearish of the two patterns.